First published in BanklessDAO’s Decentralized Law, “Together, We Go Farther” November 3, 2022.

A decentralized autonomous organization is a non-entity technological structure that facilitates social coordination and collective online decision making. DAOs are, by definition, community-led entities with no central leadership, and they sometimes govern themselves on the blockchain using smart contracts. They are particularly attractive in the digital age because the members are not limited by geographic location, enabling organization on an international level.

Unlike corporate shareholders, limited liability company members, or participants in other, more traditional legal entities, DAO members do not enjoy the type of personal liability protection granted through an entity’s fictional legal personhood. Decentralization makes conducting enforcement actions or otherwise suing a DAO more technically difficult because there is no centralized leadership, entity, or place of business. Beyond that, many DAO members are anonymous or pseudonymous, providing a further layer of insulation against legal action. Even so, a recent lawsuit against Ooki DAO has highlighted how the Commodity Futures Trading Commission (CFTC) is attempting to subject unidentified DAO members and token holders to liability — in violation of their full and fair procedural due process rights.

The CFTC's Action Against Ooki DAO

In September 2022, the CFTC issued an agreed administrative settlement order imposing a $250,000 civil penalty on bZerox (bZx) LLC and its founders, Tom Bean and Kyle Kistner. bZx and the founders did not admit wrongdoing but agreed to cease violations of federal commodities laws.

The complaint and accompanying settlement order alleged that Bean and Kistner designed the protocol as a collection of smart contracts on the Ethereum blockchain, which facilitated transactions without intermediaries and created an unregistered retail digital commodity derivatives exchange, in violation of the Commodity Exchange Act (CEA) and CFTC regulations. In the United States, these types of margin retail commodity transactions are required to take place on designated regulated contract markets, such as the Chicago Mercantile Exchange.

The CFTC concurrently commenced an enforcement action in California federal district court against bZx DAO, which had been rebranded to Ooki DAO (Ooki). The CFTC's complaint says that Bean and Kistner transferred control of the protocol from bZeroX to a DAO in August 2021 because they thought it would be “enforcement-proof.” The civil enforcement action is based on the same alleged violations by the bZx entity and its founders. According to the CFTC's complaint, Ooki is comprised of token holders who vote on the governance of the protocol, regardless of whether directly (as a token holder) or indirectly (as a delegate of a token holder), and this voting constitutes membership in an “unincorporated association” of the Ooki DAO.

The CFTC intends to prevent DAOs from using their decentralized nature and lack of legal structure to avoid liability from enforcement actions, asserting that “Ooki DAO exists for the exact same purpose as bZeroX before it — to run a business, and specifically, to operate and monetize the Ooki Protocol”, and alleging that Ooki permitted leveraged commodities transactions that can only be lawfully conducted on a designated contract market (DCM) pursuant to the CEA Act and acted as an unregistered futures commission merchant (FCM) by soliciting and accepting orders for trading on the protocol.

The CFTC also alleges that Ooki's failure to comply with Bank Secrecy Act provisions requiring FCMs to implement a customer identification program, know-your-customer (KYC) policies, and an anti-money laundering (AML) program violated CFTC rules. The CFTC has requested an injunction precluding further activity and that Ooki rescind any contracts or agreements with investors and pay restitution for funds it unlawfully obtained.

While an enforcement action against founders or their associated startup entity is not unusual, the CFTC's expansion of the action to DAO members is unprecedented and has been decried by many as arbitrary and blatant regulation by enforcement. The action is particularly unusual and novel based on the CFTC’s theory that Ooki is an unincorporated association under California law, which allows the DAO, in theory, to be sued as a whole and encompassing each alleged individual member of the association.

Putative Expansion of DAO Member and Token Holder Liability

The CFTC's decision to expand the enforcement action to DAO members is the subject of vigorous internal debate. CFTC Commissioner Summer K. Mersinger issued a dissenting statement, calling the decision to impose liability on the DAO and token holders “arbitrary” and “based on an unsupported legal theory amounting to regulation by enforcement while federal and state policy is developing”. Mersinger, a Republican who was appointed to the CFTC by President Joe Biden, said the agency should have engaged in formal rulemaking on DAO liability. “The commission's approach in these actions will have public policy implications that extend far beyond this particular settlement and lawsuit,” Mersinger said, “yet the commission has made this consequential decision with no public notice or input whatsoever. It is regulation by enforcement, plain and simple”.

One of Commissioner Mersinger's — and indeed most practitioners' who have reviewed the case — main criticisms of the CFTC's action against Ooki is that the CFTC based their theory of liability on California state law precedents from contract and tort law that hold individual members of a for-profit unincorporated association personally liable for the debts of the association. However, arguments relating to Ooki's liability are substantive arguments, meaning the CFTC is required to first comply with certain procedural requirements before it can attempt to hold Ooki DAO or its members liable.

While some of the substantive and procedural issues are intertwined, this article isn’t about whether the CFTC can hold the DAO and its members liable or enforce a judgment against them. It’s about how the CFTC has improperly served legal papers on ‘the DAO’ which has been characterized as an unincorporated association for purposes of the lawsuit to attach liability to each individual member.

In California, an unincorporated association has the ability to sue or be sued, but liability flows to the individual members jointly and severally instead of to a legal entity. Members of an unincorporated association have duties and liabilities to each other that stem from the rules of the association. The members agree — usually through a written constitution — to cooperate in furthering a common purpose, and will normally appoint a committee to manage the unincorporated association’s affairs. While clubs and charities are often constituted as unincorporated associations, the members of a management committee of a charity that is formed as an unincorporated association are likely to be trustees, which inherently limits their liability.

Unincorporated associations generally have one or more places of business or are registered with the state in some way. As noted by the CFTC, however, Ooki DAO is not registered with any state, does not have a principal place of business, and has not designated representatives to accept service on its behalf. A key characteristic of DAOs is that unrelated, and often anonymous, individuals coordinate ad hoc proposals about how to run the underlying protocol. An individual may have voted or delegated their votes on none, some, or all of these proposals.

This is in contrast with an association with a clear decision-making structure and constituency. In other words, despite the CFTC’s allegations, Ooki does not particularly look like an unincorporated association, and the CFTC’s inability to effectuate service on Ooki by standard mechanisms is just one of several factors highlighting that difference.

How Do You Serve a Chatbot?

In late September, the CFTC filed a Motion for Alternative Service asking for the court's permission to serve the DAO and its members by posting the complaint via a help chat box and posting a notice on the online forum to check the chat box. The CFTC argued that it should be able to effectuate service in this manner because the DAO has “no physical office address or any publicly identifiable persons associated with its business” and “the Help Chat Box and Online Forum are the sole mechanisms the Ooki DAO has chosen for the public to contact it directly”. In support of its request, the CFTC relies on prior 9th Circuit jurisprudence where federal district courts authorized email service on allegedly similarly situated organizations, i.e. organizations that only operated a website, had no known physical location, and provided only an email address to be contacted on the website.

In support of its Motion for Alternative Service, the CFTC supplied a detailed affidavit documenting the CFTC’s search for mechanisms to effectuate service on Ooki. The affidavit described the “extensive steps” the CFTC took to “identify an individual authorized to accept service of process on the Ooki DAO’s behalf or a physical location to which a summons and complaint could be mailed”. Efforts included searches of law enforcement databases and of business registration information in all fifty states. The CFTC also filed a supplemental motion and affidavit describing a post in Ooki’s Online Forum that refers to the litigation against Ooki. The CFTC proffered these communications about the lawsuit as demonstrative that service through the forum would provide appropriate notice to the Ooki members who were supposedly already aware of the litigation based on posts and discussions. The CFTC also argues that this method of service is appropriate and “reasonably calculated to give actual notice to the Ooki DAO because it is the method the Ooki DAO itself holds out to communicate with it”. (See Motion for Alternative Service, p.9).

The court subsequently granted the motion with minimal explanation and noted service was effective on the DAO on September 22, 2022. This means that Ooki — as a whole and with respect to each alleged member — is required to file a responsive pleading within twenty-one, sixty, or ninety days from the date of service — dependant on a variety of factors — or face default judgment against the DAO and alleged members jointly and severally.

Why Courts Are Obsessed With Procedural Due Process

In the United States court system, substance yields to procedure. What this means is that before a court can hear the merits of a legal argument, that argument must first meet certain requisite procedural requirements in its presentation to the defendant. These requirements are necessary to comply with state and federal procedural due process and ensure proper notice of the plaintiff's claims is provided in a timely manner that allows a ‘full-throated response’.

Civil actions must follow the procedures set out in the jurisdiction’s rules of civil procedure, and in the federal system, the procedures set out in the Federal Rules of Civil Procedure (FRCP). Under FRCP 4(e)(1), a plaintiff may serve a defendant according to the laws of the “state where the district court is located or where service is made”. California law, for example, allows a court to authorize “alternative service” through “a manner which is reasonably calculated to give actual notice to the party to be served …” Notwithstanding any service procedures allowed by state law, service on a defendant must also comport with constitutional notions of due process. The Due Process Clause of the Fourteenth Amendment to the United States Constitution commands,

“nor shall any State deprive any person of life, liberty, or property, without due process of law”.

The protections enumerated in the Due Process Clause require that deprivation of life, liberty, or property by adjudication be preceded by notice and opportunity for hearing appropriate to the nature of the case. These notice requirements are designed to provide a defendant the information necessary to prepare and defend against claims brought against them and prevent deprivation of the rights set forth in the Constitution.

Generally, both a summons and a complaint must be served on the defendant within a certain amount of time. Service by a process server is the most recognized mechanism, but methods such as certified mail, posting notices on property, or publication in newspapers are now widely accepted. More recently, email and social media forums have also been found to provide appropriate notice, but only in certain specific instances where the court deems the mechanism to be “reasonably calculated” to put the defendant on notice.

Due Process Must Be “Reasonably Calculated”

The Constitution does not require any particular means of service of process, only that the method selected be reasonably calculated to provide notice and an opportunity to respond. That standard was articulated in the 1950s Supreme Court's opinion in Mullane v. Central Hanover Bank & Trust Co. and has remained largely the same to present day.

In Mullane, the bank relied on a New York banking law to provide notice of a settlement to beneficiaries through newspaper publication. It is important to note, however, that while statutory notice by publication was sufficient for beneficiaries whose interests or addresses were unknown because there was “no other means of giving them practicable and effective notice,” for beneficiaries with a “known location,” the Court held statutory notice through a newspaper publication was “not reasonably calculated to reach those who could easily be informed by other means at hand”. In other words, where the identity or address of the beneficiary was known, service in-person or by mail was required.

The Supreme Court was noticeably careful not to commit itself to any formula, and balanced the individual interests sought to be protected by due process with the interests of the state. However, as time passes and as technology evolves, what mechanisms qualify under the standard of “reasonably calculated” notice has and will continue to change.

The Reasonably Calculated Standard in the Digital Age

In 2002, the United States Court of Appeals for the Ninth Circuit allowed service of process through e-mail as an alternate method in Rio Properties, Inc. v. Rio International Interlink. The court found that the defendant created a scenario where email was the only way to reach it for the purposes of service. The court opined that the defendant “acquiesced” to service via email because their business structure not only desired contact through email but also declined to list an “easily discoverable street address in the United States or in Costa Rica”. Given the circumstances, the court found that “[email] may be the only means of effecting service of process”.

The Rio court acknowledged the gravity of its decision, noting that there were no prior U.S. Court of Appeals decisions addressing the propriety and constitutionality of service of process by email. Because the Constitution only requires that the method of service selected be reasonably calculated to provide notice and an opportunity to respond, “[t]his broad constitutional principle unshackles the federal courts from anachronistic methods of service and permits them entry into the technological renaissance”.

Ten years after Rio, in Baidoo v. Blood-Dzraku, the New York Supreme Court allowed service by Facebook. “Under the circumstances presented here, service by Facebook, albeit novel and non-traditional, is the form of service that most comports with the constitutional standards of due process”. To demonstrate this method of service was proper, the plaintiff in Baidoo had to show that they could not locate the defendant — i.e. a physical address — to use the “nail and mail” or other method of alternate service.

As with the Baidoo plaintiff, the CFTC’s Motion for Alternative Service, and accompanying affidavits on Ooki included detailed affidavits (See DE 11-1 and DE 13-1) demonstrating their process, articulating why no other means of service was viable, showing the account or forum truly belonged to the defendant, and that the defendant logged in often enough to see the message. The Baidoo court made clear that “inasmuch as plaintiff is unable to find defendant, personal delivery of the summons to [the defendant] is an impossibility”. In allowing the plaintiff to effectuate service through Facebook message, the court in Baidoo emphasized that their decision would be based on the more flexible constitutional standard than the dearth of bright line precedent.

In 2018, in Democratic Nat'l Comm. v. Russian Fed'n, the Democratic National Committee (DNC) obtained leave to serve process on Wikileaks via Twitter because Wikileaks was a seemingly unincorporated “virtual” presence with no confirmable physical address. The DNC’s motion stated, “WikiLeaks is an organization of unknown structure whose primary activity is running a website, Wikileaks.org, on which it publishes confidential or classified information . . . [w]hile WikiLeaks’ physical presence is difficult to discern, it has a robust online presence, including an active presence on Twitter, using the handle @WikiLeaks”. The DNC alleged WikiLeaks was an unincorporated association and subject to service based on the same rules. WikiLeaks had also openly admitted to having read the complaint through Twitter. It is, however, somewhat distinguishable that WikiLeaks maintained P.O. box addresses in multiple locations, something Ooki clearly does not do, and service was directed to those addresses in addition to through Twitter.

While not yet attempted in a federal district court, several courts have also now allowed service via “airdrop,” including a court in the U.K. and a New York State court. These courts permitted service via transmission of a digital token to the defendant's wallet address. The service token contained a hyperlink to the relevant court filings in the case and a mechanism that allowed the data of any individual who clicked on the hyperlink to be tracked. It is not clear to what extent this mechanism of service would comport with procedural due process requirements for U.S. defendants; however, it would not be surprising to see plaintiffs attempt to utilize the mechanism in the near future in federal district court litigation.

Service of Process Outside the U.S.

One notable flaw in the CFTC's Motion for Alternative Service is its failure to address whether any Ooki defendants reside outside the U.S. This is problematic to the extent that an order allowing alternative service could be unenforceable and violate international treaties relating to service of process on non-U.S. residents outside the U.S.

Generally, a plaintiff may serve process on an individual in a foreign country under U.S. federal rules through certain specified means outlined in FRCP 4(f), including: 1) by any internationally agreed means of service that is reasonably calculated to give notice, such as those authorized by the Hague Convention; 2) if there is no internationally agreed means, or if an international agreement allows but does not specify other means, by a method that is reasonably calculated to give notice, or 3) by other means not prohibited by international agreement as may be directed by the court. As with the due process requirements discussed previously, this rule is a flexible standard that allows service through any means that comports with due process.

For example, the court in WhosHere, Inc. v. Orun allowed, along with a demonstration of proof of actual account ownership and regular use, service on a defendant located in Turkey via LinkedIn. In 2016, in St. Francis Assisi v. Kuwait Finance House, the United States District Court for the Northern District of California allowed the plaintiff to effectuate service of process on an otherwise unreachable international defendant via Twitter. However, in both of these cases the plaintiff's identity and nationality were readily identifiable.

Conversely, in Cox v. Coinmarketcap OpCo, LLC, the court denied the plaintiff’s request for alternative service via social media because “w]ithout further proof of the country of residency for the individual Defendants . . . [t]he Court can only speculate as to whether service by Twitter is prohibited by international agreement as the country of residency cannot be identified”. Similarly, with respect to Ooki, the CFTC’s allegation that alternative service on unknown defendants of unknown nationalities and residing outside of the U.S. is allowed would seem to be facially improper.

Can a Chatbot Appear in Court?

At publication of this article, no defendant has filed a responsive pleading or had counsel enter appearance in the case. However, the presiding judge, Hon. William H. Orrick, has set a remote hearing for November 30, 2022, in order to allow parties who have filed amicus curiae — friend of the court — briefs to present the arguments set forth in their briefs. See Docket Entry 28. Briefs have been filed by LexPunK, the Defi Defense Fund, and Paradigm (the Amicus Parties). Because the CFTC’s motion to effectuate alternative service was already granted, briefs filed by the Amicus Parties are being accepted and interpreted as motions for reconsideration of the court’s decision to permit alternative service on Ooki. The CFTC’s response to the Amicus Parties’ briefs is due November 7, 2022, with replies due one-week later.

The hearing will also likely address, to some extent, Ooki’s characterization as an unincorporated association under California law and its ability to sue and be sued. The substance of the Amicus Parties’ briefs is more fully addressed in our next article. The hearing can be publicly viewed via Zoom consistent with the instructions set forth on Judge Orrick’s bio page and as described at Docket Entry 28.

In Closing

Ultimately, the CFTC seeks to sanction anonymous individuals, who may reside across the world, who have not entered into a partnership or similar contract with each other, and whose only common connection seems to be their shared use of Ooki software on the blockchain. The CFTC’s main argument is that service via help chat box as well as a notice on its online forum is the appropriate mechanism for service because that is the only mechanism provided by Ooki to facilitate communication; and, based on discussion in the forum, members are aware of the lawsuit. However, this position does not take into account that while the DAO non-entity may conceivably be aware of the lawsuit and certain members of the community may be aware of the lawsuit, there are countless other token holders who are not and may be improperly determined to have been served and face default judgment.

Additionally, because of the Ooki token’s delegation feature, Ooki token holders may not have ever voted to direct the DAO, and delegation functionally renders the identity and location of the delegated voters unidentifiable. This means the token holders — at least for the purposes of service of process — are more similar to ‘doe’ defendants, requiring further investigation to properly identify and join into the lawsuit. The CFTC’s inability to identify Ooki members would also seem to further undermine the substantive argument that Ooki is a collective business enterprise directed by token holders. Ultimately, the CFTC’s novel use of California law to facilitate performative service and impose joint and several liability against countless unnamed U.S. and international token holders seems to fail to comport with notions of fair play and procedural due process.

If the CFTC is able to circumvent procedural due process requirements through alternative service mechanism that do not actually put every potential defendant on notice, the flawed substantive argument that Ooki is an “unincorporated association comprised of Ooki Token holders” cannot effectively be addressed through dispositive motion or subsequent presentation of evidence, and that is why substance must always yield to procedure.

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*lawpanda is a U.S. attorney with an active litigation and counseling practice assisting builders, developers, traditional companies, and decentralized communities. He is a member of  BanklessDAO’s Legal Guild, LexDAO, LeXpunK, the Blockchain Lawyers Group, and member/consultant/contributor to a variety of DAOs and protocols. When he’s not writing for Decentralized Law, he is working to reduce operational and governance friction between on-chain and legacy entities through corporate structuring and common-sense legal solutions. Read his scribblings on Mirror and connect on Twitter, LinkedIn, or at lawpanda.eth@gmail.com. *

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